2 Key SaaS Metrics to Chart a Path to Profitability for Investors

Profitability is not the be-all and end-all for startups. It might be as important — or even more important — to grow your customer base and grab market share first, while you’re still disrupting the existing market. Still, investors will at least want to see a path to profitability, and two key SaaS metrics that will help you chart that path are Customer Acquisition Cost (CAC) Ratio and Customer Lifetime Value (CLTV).

In this article, you’ll learn how to chart a path to profitability. We’ll show how to calculate customer acquisition cost, how to calculate customer lifetime value, and how to figure out your CLTV to CAC Ratio. Let’s get down to business by starting with an overview of the CAC Ratio.

What is CAC Ratio?

The customer acquisition cost (CAC) ratio is a comparison of two factors: the total sales and marketing expenses associated with gaining a new customer, and the incremental increase in the gross profit associated with those new customers during a given period of time.

Why your CAC Ratio Matters

Depending on which number you use as the numerator and which you use as the denominator, the CAC Ratio will either tell you the percentage of your expenses that will be recovered during a particular time period (gross profit for given time period / expenses) or the time it will take to recover the expense associated with acquiring the new customers in the first place (expenses/ gross profit for a given time period).

As such, the CAC Ratio is an important tool for understanding how long it will take to recoup your sales and marketing investment. In fact, that’s why the calculation uses gross profit rather than total revenue, because what really matters is how much you actually earned from that customer after factoring in the cost of goods sold.

Gross Margin vs. Profit Margin

Not all SaaS companies do a good job calculating gross profits, which leads to over-inflating your CAC, so it’s worth pointing out the difference with profit margins.

Here’s a simplified example for a fictitious software company making apps:

The gross profit for this tech company is $400,000 ($500K-$100K), which makes their gross margin 80 percent ($400K/$500K).

Software companies often have a high gross margin because the cost of goods sold is relatively minimal and limited to unavoidable expenses, such as server costs and hosting costs.

However, the app company has a lot of operating expenses: They need to rent office space, pay salaries to developers and sales people, and budget money for marketing and advertising. The operating expenses of tech companies are usually a lot higher than the cost of goods sold, but operating expenses are variable and can be reduced to control burn.

Once operating expenses are also deducted, the net income for the startup is $100,000 ($500K-$100K-$300K), which makes the profit margin 20 percent ($100K/$500K).

How to Calculate Your CAC Ratio

Here is the formula for calculating your CAC ratio:

Annualized Gross Profit for period Q / Sales and Marketing Expenses for period Q

Where to get the data to calculate your CAC Ratio

Calculating your CAC Ratio is sometimes done manually, combining disparate pieces of data from both your CRM and accounting software. If your organization has a CFO or employees business analysts, they’d perform this type of analysis. If you’re not yet tracking this metric, you should jump on the bandwagon — it’s a commonly used data point, especially within the tech space.

Moving on to the next important SaaS metric, we’ll cover how to calculate customer lifetime value, why it matters, and how tracking it can help you chart a path to profitability for investors.

What is Customer Lifetime Value (CLTV)?

Customer Lifetime Value (CLTV) is the total amount of revenue, on average, you expect to earn per customer.

Put another way, CLTV is an estimate of the total subscription value of an average customer. As the name implies, CLTV measures the value over the entire lifetime of a customer.

Why Customer Lifetime Value Matters

Knowing how much revenue you can expect to generate for an average customer is helpful for forecasting and budgeting purposes. It can give you a good sense of how much revenue you expect to generate, especially using a bottom-up forecasting approach. Knowing this allows you to make sound business decisions, including expanding your team, or directing your marketing efforts.

When viewed in isolation, however, CLTV doesn’t give you the whole picture. It’s much more valuable to view your CLTV relative to the average cost to acquire a new customer (CAC). Ultimately, it helps you figure out if you earn enough revenue per customer to balance out the cost of acquiring that customer.

How to Calculate Customer Lifetime Value

One way to calculate Customer Lifetime Value is with this formula:

CLTV = Average Revenue Per Account (ARPC) x Average Customer lifetime

Is there a particular value that SaaS companies should be targeting? There is no “right” answer, because it’s not your standalone CLTV that really matters. What matters is your CLTV relative to your CAC. A Customer Lifetime Value of $5,000 might sound great initially, but that number isn’t very impressive when the Customer Acquisition Cost is $5,500.

At a minimum, you want CLTV to be greater than your CAC. If you are spending more to acquire the average customer than you gain from them, your business is destined to fail. This may seem obvious, but seemingly promising startups can be hyper-focused on growing their customer base fast without considering the risks of spending too much on their customer acquisition efforts.

As a general rule of thumb, a good goal to shoot for is a CLTV that’s 3 times more than your CAC. This provides a buffer for unexpected variations — such as higher acquisition costs or a shorter customer lifetime — while still generating an attractive margin.

Where to get data to calculate Customer Lifetime Value

You can get the lifetime value of your customers from your accounting software. As mentioned above, you may also want to look into third-party software to track this metric.

Customer Lifetime Value Example Calculation

For our example CLTV calculation, let’s assume the name SaaS Company.

SaaS Company offers two different pricing options: Basic ($10/month) and Premium ($15/month). SaaS Company has 1,000 Basic and 1,000 Premium customers. Average customer lifetime varies by pricing plan.

Average Customer Lifetime

Basic: 12 months

Premium: 24 month

With this data, we can calculate the CLTV of the company’s average customer:

CLTV = [($10 x 1,000 x 12) + ($15 x 1,000 x 24)]/ 2,000 = $240

This means that, on average, SaaS Company can expect to generate $240 in revenue per customer.

So, how effective are your marketing and sales efforts? Do you know how much it costs to bring in new customers — and how that compares to what you expect to earn from customers over their lifetime? Enter the CLTV to CAC ratio, a key SaaS metric that can yield insights into how efficiently your company is spending on marketing, sales and customer retention.

What is CLTV to CAC Ratio?

The CLTV to CAC Ratio is the total average value you expect to receive from a new customer compared to the average cost to acquire a new customer.

CLTV: Customer Lifetime Value

CAC: Customer Acquisition Cost

Why CLTV to CAC Ratio Matters

The CLTV to CAC Ratio summarizes a plethora of information — including anticipated average lifetime revenue per customer, customer churn, and sales and marketing costs — into a single number that can be easily understood and used to evaluate the future prospects of your business. In the long run, this metric can be used to show investors your path to profitability and highlight the value of your company. It can also tell you whether or not you’re in a strong enough position to lure in equity investors.

Ultimately, the question you’re trying to answer is:

“On average, do we earn more revenue per customer than the cost to acquire new customers?”

If the answer is “yes,” you might have a chance of being a successful company. If the answer is “no,” you probably won’t be in business for long.

The exception is if you’re in the early stages of your SaaS startup. In this case, your CLTV is likely to be quite low relative to your CAC. This isn’t necessarily an issue — as long as you expect your CLTV to trend up over time relative to your CAC.

High vs. Low CLTV to CAC Ratio

A high CLTV to CAC Ratio means you have the potential to grow faster — and need less capital to do so! Companies with higher CLTV to CAC Ratios typically have higher valuations and an easier time securing funding from investors.

A low CLTV to CAC Ratio means your company is not as efficient at acquiring high value customers, and will likely need more capital to fuel revenue growth. The need for more capital and the slower growth rate means lower valuations from investors.

So, what’s a high or low CLTV to CAC Ratio? Although average CLTV/CAC Ratios vary across industries and business models, a general rule of thumb is that you should aim for a CLTV to CAC Ratio of at least 3:1, especially if seeking equity investors. This provides the necessary profit to invest in continued growth, and allows for a cushion should CLTV decrease or CAC increase.

However, this is not to say that a business cannot thrive with a CLTV to CAC Ratio of less than 3. If you do not desire or need a large exit, and if you’re not looking to raise equity, having a high CLTV to CAC Ratio is less important. Debt investors, for example, are more interested in seeing a stable or slightly expanding CLTV to CAC Ratio than in a CLTV to CAC Ratio that’s greater than or equal to 3.

Where to get the data to calculate CLTV to CAC Ratio

You’ll need both CRM data and a well-organized accounting system to figure out your CLTV to CAC Ratio.

Summary

Tracking these metrics will help you gain new insights about your business, and help you make better decisions. Having a clear understanding of how your company is performing against key SaaS metrics demonstrates that you know your business well, which is critical when you get in front of investors.

Two key takeaways about sharing your company’s data with potential investors or lenders:

1.Make sure your metrics go beyond just a “snapshot.” You’ll want to show how your key indicators have evolved over time, and how your company compares to industry peers and competitors, if the data is available.

2.Make sure your data is clean and easily consumable — a link to an online dashboard is great, but a simple PDF or similar will work to share metrics reports. If you’re prepping financial information, again, you need to make sure your information is clean and easy to understand. Messy or impossible to follow financials are not only hard to evaluate, they may cast doubt on the reliability of the information and your company’s credibility. We recommend using SaaS accounting software such as QuickBooks, which integrates with many third-party tools and systems, including Lighter Capital’s application process.

Want More SaaS Metrics?

Want a more comprehensive look at the most important metrics investors look for when funding tech companies? There are many numbers, statistics, and metrics to calculate, track and assess the health of your technology business; so many, in fact, that reliable measurement can seem overwhelming.

This guide explains the core metrics used to measure SaaS company success. Using simple examples, we’ll show you how to calculate each metric, and describe why specific indicators are important to investors.